PFICs: why that local index fund is a US tax headache

A foreign mutual fund or ETF is almost always a PFIC, and the IRS taxes PFICs in a way built to make you regret owning them.

The short version

• A passive foreign investment company (PFIC) is a non-US company where 75% or more of gross income is passive, or at least 50% of assets produce passive income [1]. Most non-US funds meet that test.
• Without an election, gains and large distributions fall under the excess distribution rules of section 1291: ordinary income plus a separate tax and interest charge on amounts spread back over earlier years [1].
• Each PFIC generally needs its own Form 8621, attached to your return [1].
• The QEF and mark-to-market elections soften the blow, but each has limits [1].
• Many Americans abroad hold US-domiciled funds through a US broker, individual shares, or local pension plans instead.

What a PFIC is

The PFIC rules were written to stop Americans from parking money in offshore funds and deferring US tax. They cast a much wider net than that. The definition has two tests, and a foreign corporation is a PFIC if it meets either [1]:

A fund that holds stocks and bonds earns dividends, interest and gains. That's passive income, so nearly every fund domiciled outside the US is a PFIC. It doesn't matter that the fund tracks the S&P 500, or that it's a regulated product your bank sells to everyone on your block. In Europe, that includes the common UCITS funds and ETFs listed in Dublin, Luxembourg or Frankfurt. Elsewhere it includes the local unit trusts, managed funds and many investment-linked insurance products sold by banks.

Some things are generally not PFICs: shares in an operating company like Nestlé or Toyota, cash in a bank account, and US mutual funds and ETFs (they're US companies, not foreign ones). The plain-vanilla index fund in your 401(k) back home is not the problem.

Why the default tax is so harsh

If you hold a PFIC and make no election, it's a "section 1291 fund" [1]. Two events trigger the punitive regime:

1. An excess distribution. Any distribution above 125% of the average distributions of the prior three years (or your shorter holding period) [1].
2. A sale or other disposition at a gain. The whole gain is treated like an excess distribution.

The excess amount is spread over every day you held the fund. The part allocated to the current year and to years before the company was a PFIC is ordinary income. The part allocated to earlier PFIC years is hit with a separate tax plus an interest charge under section 1291(c) [1]. That tax is figured at the top rate for each earlier year, not your own bracket.

The result: long-term gains that would be taxed at capital gains rates in a US fund become ordinary income, and a buy-and-hold investor ends up paying interest for "deferring" tax they had no way to pay. The longer you hold, the worse it gets. It's a lousy deal by design.

The two elections

Mark-to-market is the workhorse, the one most people can actually use, because exchange-traded funds and many regulated funds qualify as marketable. You pay tax every year on paper gains, at ordinary rates, but you avoid the interest charge. If you've held the fund for years before electing, the first year can still pull in section 1291 treatment. A US expat tax preparer can check your situation before you elect.

Form 8621: the paperwork

You file a separate Form 8621 for each PFIC, attached to your return by its due date, including extensions [1]. Own six funds and you're looking at six forms, which is why preparers wince at this one. The current instructions are the December 2025 revision [1].

There's a narrow exception. You don't complete Part I (the annual report) if the total value of all your PFIC stock is $25,000 or less on the last day of the year, or $50,000 or less on a joint return, and you had no excess distribution or gain on a section 1291 fund [1]. If you own a PFIC indirectly through another fund, the threshold for that holding is $5,000 [1]. As soon as you sell, receive a large distribution, or make or report an election, you file the full form.

Two other rules help:

• Retirement accounts. A US person who owns PFIC stock through an IRA or certain other tax-exempt accounts is not treated as a PFIC shareholder [1].
• Treaty-recognized foreign pensions. Members of some pension arrangements treated as foreign pension funds under a US tax treaty may not need to complete Part I [1].

PFICs also connect to other forms. If you report a PFIC on a timely Form 8621, you don't list it in detail on Form 8938, but its value still counts toward the 8938 threshold [2]. For Americans living abroad that threshold is more than $200,000 at year-end or $300,000 at any time if unmarried, and $400,000 or $600,000 if married filing jointly [2]. The fund account itself is also a foreign financial account for the FBAR once your accounts together pass $10,000 [3].

What Americans abroad invest in instead

There's no one-size-fits-all answer, and it depends on your host country's tax rules too. Common approaches:

1. US-domiciled funds at a US broker. A US mutual fund or ETF isn't a PFIC. The challenge is keeping a US brokerage account with a foreign address, and some countries' rules make it hard for local residents to buy US-listed funds through local platforms.
2. Individual stocks. Shares in operating companies, US or foreign, avoid the PFIC rules. You give up the easy diversification of a fund.
3. Local pensions and tax-favored plans. Workplace pensions are often treated differently, especially where a treaty covers them. Check the treaty and the Form 8621 instructions on foreign pension funds [1]. If your partner is Australian, our sister site ExpatCooee explains how their super works while you live overseas.
4. Direct bonds and deposits. Government bonds and bank deposits aren't PFICs, though they're taxed as ordinary interest.
5. US retirement accounts. PFIC rules don't apply to holdings inside an IRA [1], and you may still be able to fund one if you have earned income that isn't excluded.

If you already own PFICs

Don't panic-sell without running the numbers first. Selling triggers the excess distribution calculation, and you may also owe local capital gains tax. Options include selling now to stop the interest from growing, making a mark-to-market election going forward, or holding small positions under the Part I exception. If you've missed Forms 8621 in past years, the Streamlined procedures let non-willful filers include them with the catch-up returns [4].

Common mistakes

• Trusting the bank's label. "Low-cost index fund" says nothing about US tax treatment. Your friendly local banker isn't thinking about the IRS.
• Reinvesting dividends automatically. Each purchase is a new lot with its own holding period and calculation.
• Forgetting kids' accounts. A US citizen child holding a foreign fund is a PFIC shareholder too.
• Missing the election deadline. The QEF election has to be made on a timely return for the first year it applies [1].

Sources

1. IRS, Instructions for Form 8621 (Rev. December 2025)
2. IRS, Instructions for Form 8938
3. FinCEN, Report Foreign Bank and Financial Accounts
4. IRS, U.S. taxpayers residing outside the United States (Streamlined Foreign Offshore Procedures)

Keep reading

• FATCA and Form 8938 for Americans abroad
• Catching up on missed US tax returns: the Streamlined procedures
• 401(k) and IRA when you live abroad
• US brokerage accounts while living abroad